(MENAFN- Khaleej Times) Businesses have access to different modes of financing, and debt financing is a popular option. The cost of borrowing through debt financing commonly referred to as interest is typically lower than the cost of equity. So, a taxable person can opt for more debts without considering the optimum capital structure.
To discourage excessive debt financing and to ensure that debt is being raised exclusively for business purposes and there is a valid commercial reason for obtaining the loan, interest capping rules have been introduced in Article 30 of the UAE corporate tax law (UAE CT Law). For further clarity, and guidance Ministerial Decision No. 126 of 2023 (the decision) has been published.
Interest is the amount incurred to raise finances; and interest capping rules are applicable to the net amount of interest, which is equal to interest expense less interest income; if any. It is important to note that any amount incurred to raise finances, like guarantee fee, arrangement fee, commitment fee etc, has also been classified as interest in the UAE CT law. Like if Xezo Ltd, along with the actual interest, paid one per cent loan processing to the bank; and agency fee three per cent, it will also be classified as interest expense for businesses purposes.
Interest element in the derivatives, financial return in the form of interest on financial assets and financial liabilities will be considered interest. Interest equivalent component in the Islamic financial instruments, and finance element in the finance lease and non-finance lease will be treated as interest. Any foreign exchange gain or loss related to the interest will be considered interest income or interest expense respectively.
Mahar Afzal is a managing partner at Kress Cooper Management Consultants.
The general interest deduction limitation rule is that a taxable person can claim maximum of 30 per cent of adjusted earnings before interest, tax, depreciation and amortisation (Ebitda) during a tax period, and the remaining net interest amount will be carried forward for a further period of ten years in the order in which the amount was incurred. The Ebitda will be higher of the zero or the amount calculated above. While calculating Ebitda, exempt income will not be included. Similarly, any interest expense or income related to the exempt income will also not be considered while calculating the net interest amount.
Where interest element has been capitalised as required by the applicable accounting standards, then upon unwinding, related component of income or expenses will be subject to interest capping rules.
The above are general interest deductions rules. There are certain exceptions like if net interest amount is up to Dh12 million during a tax period, the interest capping provisions will not apply, and the entire amount of net interest can be claimed by the taxable person. Where the net interest for the tax period is more than Dh12 million, then the higher rate of 30 per cent of Ebitda and Dh12 million can be claimed as interest allowable expense. Where the relevant tax period is more than or less than 12 months, Dh12 million will be adjusted proportionately. Like if the tax period is of six months, then the limit will be of Dh6 million; and for 18 months tax period, it will be Dh18 million.
The general rules are not applicable to banks, insurance companies; and natural persons undertaking business in the UAE. If the bank or insurance company is part of the tax group, then any income and expenditure of the bank and insurance company shall not be considered while calculating the net interest and adjusted Ebitda of the Group.
The resident persons who are responsible for, or who facilitate the provision, maintenance, or operation of qualifying infrastructure projects (QIPs) are called the QIP persons. The net interest on loans for financing of the QIP is not subject to general interest deduction limitations rules. The QIPs are the long-term infrastructure projects that are exclusively for the welfare of the public. The QIP person can claim entire amount of net interest expenditure incurred from the financing of QIP, if the QIP meets certain conditions like QIP is for the benefit of the UAE public only, and exclusively for providing transport, utilities, education, healthcare, and any other specified service. The entire assets of the QIP that expected to last for at least ten years, are in the UAE; and these assets cannot be disposed at the discretion of the QIP person. The entire interest income and interest expenses related to the QIP arise in the UAE etc.
The loan that was agreed before December 09, 2022, allowed amount of interest will be lower of the interest amount calculated based on the original terms and amount computed based on the revised terms. Disbursement of loan after December 09, 2022, upon fulfilment of conditions will not be considered change in the terms and/or fresh loan.
If a loan is acquired from a related party to finance income that is exempt from CT, interest on such loan from the related party will not be deductible unless the taxpayer can demonstrate that the primary purpose of obtaining the loan and carrying out the transaction is not to gain a CT advantage. For example, interest on a loan taken from a related party to pay the related party for dividends, profit distribution, the redemption of or contribution to share capital or acquisition of ownership interest in a person who is or becomes a related party following the acquisition, shall not be allowed if this transaction has been executed to take CT advantage. The corporate tax advantage shall not be deemed to have risen if the related party (lender) is liable to pay a nine per cent or higher corporate tax or similar tax on the interest income earned.
Based on the above requirements of the law, we recommend that the taxable persons are required to have proper impact assessment, and interest on debt, if any should be claimed based on the principles mentioned above.
Mahar Afzal, a managing partner at Kress Cooper Management Consultants, has shared a personal opinion which does not represent the official stance of Khaleej Times. If you have questions or require further clarification, contact Mahar at .
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